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Friday, January 15, 2016

Richard Thaler: Misbehaving: The making of behavioral economics

Richard Thaler's "Misbehaving: the Making of Behavioural Economics" is partly an autobiography and partly a history of the development of behavioural economics. It is split into 8 parts: (i) Beginnings 1970-78 details his early interest in the psychology of decision making discussing his work on the statistical value of life and how this led to an interest in the endowment effect and his more general interest in how people deviate from rational economic assumptions. Chapter 4 contains a very useful outline of the development of Prospect Theory by Kahneman and Tversky (ii) Mental Accounting 1979-85 outlines the development of the literature on mental accounting. There is a lot of very useful material on the key ideas in the mental accounting literature and explanations of the main experiments. (iii) Self-control 1975-88 describes the development of his work on self-control, will-power and how this literature subsequently developed. The section provides very useful linkages from the will-power and intertemporal inconsistency work to the historical development of Economics and 20th century debates about consumption and income in Economics. (iv) Working with Danny: 1984-85 tells the story of the development of his collaboration with Daniel Kahneman including the development of the famous endowment effect work (v) Engaging with the Economics Profession charts the development of his "anomalies" column in the Journal of Economic Perspectives and the wider reception of the behavioural work in Economics. It also describes the development of a cohort of academics in this area through the US graduate school system and dedicated summer school sessions. (vi) Finance 1983-2003 describes the development of behavioral finance giving detailed accounts of debates around CAPM and the Efficient Markets Hypothesis and the ideas behind Thaler and colleagues' critiques. This section would be a very useful addition to a course on principles of Finance particularly at MBA or similar levels. (vii) Welcome to Chicago: 1995 to Present describes his transition to the University of Chicago and the development of his interest in law and collaboration with Cass Sunstein. It also describes his work on the NFL and on game-shows. The famous Goldenballs episode, familiar to most readers of this blog, makes a prominent appearance! (viii) Helping out: 2004 - Present: charts the development of his applied work including the well-known Save More Tomorrow work and the development of Nudge and his role in the development of the Behavioural Insights Team. He then concludes with ideas of how behavioural economics might progress including the potential development of behavioural macroeconomics, wider use of field experiments and wider and more innovative data collection.

This is a really good book and works on a number of levels. Thaler has spent a lot of time out and about among people working in different sectors and has developed (perhaps aided by the discipline of publishers) a strong ability for story-telling and he captures the importance of the key debates he has been involved in across economics, finance and law very well. The descriptions of some of the key concepts in behavioural economics are well suited to a broad audience and provide a lot of background information that will be of interest also to those who are already very familiar with the concepts. There are echoes of Arjo Klamer's famous book "Conversations with Economists" throughout the book, with Thaler aiming to give a sense of the institutional context and personalities that framed the key debates in these areas. It is fair to say that this is from the view point of one side of the debate and it would be interesting to hear more from the other side. Some of the key protagonists on the rational choice side of economics often emerge as fairly one-dimensional characters in the narrative and you feel you never really get a strong sense of what motivates some of the key figures who dominated rational-choice Economics throughout the 20th century. Having said that, Thaler does tell his side of the story extremely well and gives the context for how some of his key contributions - including his role in the development of behavioural economics, the development of behavioural finance and the development of Nudge - came to happen.

One particularly useful aspect of the book for me was Thaler's description of the role of Thomas Kuhn's "Structure of Scientific Revolutions" in framing his ideas on the role of behavioural economics. Thaler talks explicitly about how he had always viewed the development of behavioural economics as being a paradigm-shifting movement that would initially come about by pointing out several anomalies that cannot be explained by the neo-classical paradigm. It is interesting to see a self-aware paradigm shift in a discipline and the book operates nicely as a description of how this happened. Chapter 17 "The Debate Begins" has some remarkable passages on a 1985 conference bringing rationalists and behaviourists together to debate the behavioural literature and gives a real sense, at least from the behavioural side, of what was at stake in these debates and the passions they aroused. We see similar moments in later chapters on finance and law with academic debates being mixed with high degrees of emotion and rancour.

Overall the book works as an academic autobiography, first-hand account of the development of a paradigm and gentle primer of the core concepts in the areas of behavioural law, economics and finance. It is also more than the sum of these parts as the interconnection between these three functions is highly instructive in places. It is well worth reading for anyone interested in this area.